A new study from the Tippie College of Business used the results of Fortune magazine’s annual list of Most Admired Companies to find fraud lawsuits that are dismissed as lacking merit or settle quickly do not cause any long-term reputational damage to the defendant firm.
This is important from a policy standpoint because it calls into question the case for tort reform that business interests make before Congress and state legislatures. Dain Donelson, professor of accounting at Tippie, says that businesses want to make it more difficult to file lawsuits against them because frivolous lawsuits damage their reputation and unfairly lower their firm value.
Donelson looked at 229 companies listed among Fortune’s most admired that were sued for fraud between 1995 and 2012. He found that in cases where the suit was dismissed as non-meritorious or settled for a small nuisance amount, the defendant firm suffered no long-term reputational damage as measured on Fortune’s list.
He said more meritorious cases did have stronger effects on reputation, which led to drops in stock price, cost of equity and debt, and other financial factors. However, Donelson said meritorious fraud cases are infrequent. More than 70% are eventually dismissed as non-meritorious or settled quickly, so most lawsuits are not going to cause long-term reputational damage.
While policymakers may want to put limits on fraud complaints based on so many of them being dismissed or settled before trial, Donelson said doing so to prevent reputational damage is not a legitimate reason.
He said the findings also suggests companies can minimize reputational damage from a lawsuit by settling quickly.
Donelson’s study, “The Merits of Securities Litigation and Corporate Reputation,” was published in the current issue of Contemporary Accounting Research.
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